Fall 2017 | Employee Benefits Committee Newsletter

A Rule in Flux

By: Karen L. Handorf, Partner & Daniel Sutter, Legal Fellow, Cohen Milstein Sellers & Toll PLLC (Washington, DC)

As litigation about the legality of the Department of Labor’s controversial Fiduciary Rule1 reaches federal circuit courts, the current administration has turned into the Fiduciary Rule’s biggest adversary.

Over a year ago, insurance companies started a broad offensive against the Fiduciary Rule in federal courts across the country. Challengers to the rule have filed six cases in three federal district courts to date. Despite the success of the Department of Labor (“DOL”) in defending the Fiduciary Rule, recent changes of position by the Department of Justice and DOL have cast a shadow over the Fiduciary Rule’s future.

Background

The Fiduciary Rule (the “Rule”) was the product of rulemaking that started nearly eight years ago, in 2010.2 DOL sought to replace its 1975 regulation’s five-part test for fiduciary status with a new interpretation of ERISA’s definition of an investment advice fiduciary.3 In 2011, DOL withdrew that proposal, and on April 20, 2015, issued a new proposal that again sought to replace the 1975 definition and also sought to revise administrative exemptions under which fiduciary investment advisors may obtain relief from ERISA’s prohibited transaction provisions.4

DOL was concerned that its 1975 definition of “fiduciary” no longer covered many of the financial services provided to retirement investors in the 21st century.5 Of particular concern was the individual retirement account (“IRA”) market.6 According to a 2017 survey by the Investment Company Institute, IRAs hold $8.2 trillion in retirement assets.7 This number is likely to increase substantially over the next five years as DOL estimates plan participants will rollover more than $2 trillion of assets from ERISA-protected 401(k) plans into IRAs.8 Given the size of this market and the ERISA enforcement gap, DOL sought to promulgate a rule that protects individuals from the detrimental effects that conflicts of interest have on their retirement savings.9

The regulation resulting from DOL’s rulemaking imposes fiduciary status on a financial professional that provides investment advice to an individual or a Title I plan for a fee, whether or not that advice is given on a “regular basis”.10 This brought under ERISA’s umbrella a number of investment advisers who provide advice on a one-time basis.

The rule also revised the administrative exemption structure under which fiduciary investment advisers may obtain relief from ERISA’s prohibited transaction rules when they recommend the purchase of proprietary investment products in which they have an economic interest. The exemptions allow fiduciaries to engage in these transactions if they comply with conditions designed to mitigate their conflict of interest. The rule includes the new Best Interest Contract Exemption (“BICE”) requiring relevant fiduciaries to (1) give advice in the retirement investors’ best interest; (2) charge only reasonable compensation for the services provided; (3) disclose material information to the retirement investors, such as conflicts of interest; and (4) enter into contracts with the retirement investors that promise the fiduciary will adhere to these standards, without limiting liability or requiring class action waivers.11 DOL also revised Prohibited Transaction Exemption 84-24 to include a requirement that fiduciaries comply with the same impartial conduct standard in the BICE and to limit its application to transactions involving fixed-rate annuities rather than variable and fixed-index annuities (whose rates of return are linked to a market rate rather than pre-determined rates).12 These products are sold to retirement investors on a one-time basis, bringing the financial professionals who sell the products for compensation under the purview of the Rule.

The Challenge

Starting in June of 2016, two months after DOL published the Rule, a wave of lawsuits flooded the courts as organizations that sell or have an interest in the aforementioned annuity products brought a coordinated challenge to the Rule.

The Chamber of Commerce, Financial Services Institute and Financial Services Roundtable, among others, filed the first lawsuit on June 1, 2016 in the Northern District of Texas. This case was consolidated with two other cases filed a week later in the Northern District of Texas by numerous trade associations representing the interests of insurance companies and numerous insurance companies. Around the same time, the National Association of Fixed Annuities filed a lawsuit in the District Court for the District of Columbia, and Market Synergy Group, Inc., a licensed insurance agency, filed a lawsuit in the District of Kansas. And then, finally, Thrivent, a religiously oriented financial services organization, filed a lawsuit in the District of Minnesota on September 29, 2016.

The Plaintiffs in these cases mounted an offensive that sought to stop DOL from implementing the Rule and otherwise challenged the legality of the Rule on multiple grounds.

Plaintiffs alleged that DOL exceeded its authority by applying the Rule to the individual retirement market when Congress limited DOL’s regulatory authority to employer sponsored plans. They further allege that ERISA’s fiduciary definition only covers fiduciaries who participate in the ongoing management of a plan or its assets, relying on the common law meaning of “fiduciary” and Congressional failure to change the statutory definition in the 40 years since ERISA was passed.

Plaintiffs next challenged that DOL failed to follow proper administrative procedures when promulgating the Rule, arguing it did not provide adequate notice and comment opportunity; failed to explain the reasoning behind the shift in the fiduciary definition; and failed to consider the costs and benefits of the rule. Of particular concern for Plaintiffs was DOL’s decision to treat fixed-index annuities the same as variable annuities after the 2015 notice and comment period ended.

Finally, Plaintiffs challenged that the Rule comes into conflict with existing laws and the Constitution. Plaintiffs argued that the Rule created a private right of action—something reserved for congress; used terms, including reasonable compensation, that were unconstitutionally vague; burdened free speech of insurance companies in violation of the First Amendment; and comes into conflict with the Federal Arbitration Act by restricting the use of arbitration agreements.

The Courts’ View

Plaintiffs’ arguments failed to persuade the three district courts that have so far ruled on their arguments. On November 4, 2016, Judge Randolph Moss in the District Court for the District of Colombia rejected all of Plaintiffs’ challenges and upheld the validity of the Rule.13 Then on February 17, 2017 and February 24, 2017, Judges Daniel Crabtree of the District of Kansas14 and Barbara M. G. Glynn of the Northern District of Court Texas15, respectively, followed suit.

Generally, the courts have explained that Congress gave DOL expansive interpretive authority to define technical terms, pass regulations, and create exemptions. DOL did just this when it designed the Rule: it defined what it means to give “investment advice”—a technical term—and passed an exemption that allowed fiduciaries to conduct otherwise prohibited activities if they met certain conditions, like acting in the retirement investor’s best interests and entering into a contract to that effect.16

The courts also found that DOL satisfied its procedural requirements when promulgating the Rule. Although the final Rule varied from proposals, for instance, by treating variable and fixed-index annuities the same, the courts held that the final rule was a “logical outgrowth” of the proposal, and commenters thereby always had knowledge of the Rule’s substance.17 Moreover, the courts held that DOL considered and took into account commenters’ concerns, and considered the cost and benefits of the Rule.18

All other challenges similarly fell flat. The courts held that the Rule created no new cause of action because the only cause of action available to injured parties is breach of contract, which is based in state law.19 The Northern District of Texas rejected the Chamber of Commerce’s First Amendment challenge on the basis of the “Professional Speech Doctrine,” which holds that a rule that regulates conduct and only has incidental effects on speech does not violate the First Amendment.20 The courts also rejected Plaintiffs’ vagueness argument, explaining that Plaintiffs had ample notice of what “reasonable” means, because it is “ubiquitous” in the law and common in financial statutes.21 And finally, the Northern District of Texas held that limiting class action waivers does not prevent a financial professional from enforcing an arbitration agreement and therefore does not violate the Federal Arbitration Act.22

Plaintiffs in these cases have filed appeals in their respective circuits. Although DOL’s success in the lower courts might be indicative of the Rule’s likelihood of surviving appeals, recent actions by the current administration have put the Rule’s future in flux.

The Rule’s Future

Despite the success DOL has had in the lower courts, the Trump administration has cast a shadow over the Rule’s future. On August 31, 2017, DOL filed a notice of proposed amendments seeking to delay the implementation of the Rule’s key provisions so that DOL can consider possible changes to the Rule.23 The provisions targeted by the delays include the requirement that a fiduciary under the Rule operate in a retirement investor’s best interest. Following the notice and comment period for this proposal, DOL, on November 24, 2017, officially delayed implementation of the Rule’s key provisions for 18 months until July 1, 2019.24 DOL also recently filed a brief in the Fifth Circuit stating the United States Government “is no longer defending” the validity of BICE’s prohibition against class action waivers.25

Although the courts considering the Rule have not allowed delays in implementation to moot the issues before them26, the recent actions by the Trump administration do not bode well for the Rule and put courts in between a rock and a hard place. Indeed, Judge Nelson in the District of Minnesota recently granted Thrivent’s preliminary injunction request, explaining DOL’s concession “that the anti-arbitration condition violates the FAA” tilted the scales of equity in favor of not enforcing the Rule against Thrivent.27 At the same time, the District of Minnesota has stayed Rule litigation before them until DOL has had an opportunity to develop its about-face, and the D.C. Circuit has held the litigation before it in abeyance until the Fifth Circuit has issued a ruling in the Chamber of Commerce’s appeal.


129 C.F.R. 2509, 2510, and 2550
2Definition of the Term “Fiduciary,” 75 Fed. Reg. 65,263 (proposed Oct. 22, 2010) (to be codified at 29 C.F.R. 2510).
3Id.
4Definition of the Term “Fiduciary;” Conflict of Interest Rule–Retirement Investment Advice, 80 Fed. Reg. 21,928, 21,932 (proposed Apr. 20, 2015) (to be codified at 29 C.F.R. pts. 2509 and 2510).
5Id. at 21928-30.
6Id.
7Retirement Assets Total $26.1 Trillion in First Quarter 2017, Investment Company Institute, https://www.ici.org/research/stats/retirement/ret_17_q1.
880 Fed. Reg. at 21928-32.
9Id. at 21930.
10Id. at 21934.
11Final Fiduciary Definition, 81 Fed. Reg. at 20,946; Final BICE, 81 Fed. Reg. at 21,002; Final PTE 84-24, 81 Fed. Reg. at 21,147.
12Final PTE 84-24, 81 Fed. Reg. at 21,148. Conrad de Aenlle, Annuities Not For Everyone, But They Have A Place, NEW YORK TIMES (Mar. 12, 2014), http://www.nytimes.com/2014/03/13/business/retirementspecial/annuities-notfor-everyone-but-they-have-a-place.html?_r=0 (explaining how variable and indexed annuities are tied to the performance of financial markets).
13Nat'l Ass'n for Fixed Annuities v. Perez, 217 F. Supp. 3d 1 (D.D.C. 2016).
14Mkt. Synergy Grp., Inc. v. United States Dep't of Labor, No. 16-CV-4083-DDC-KGS, 2016 WL 6948061, at *28 (D. Kan. Nov. 28, 2016).
15Chamber of Commerce of the United States of Am. v. Hugler, 231 F. Supp. 3d 152, 168-181 (N.D. Tex. 2017)
16Fixed Annuities, 217 F. Supp. 3d at 23-29; Chamber of Commerce, 231 F. Supp. 3d at 168-181. See also Mkt. Synergy, 2016 WL 6948061, at *28.
17Fixed Annuities, 217 F. Supp. 3d at 47; Chamber of Commerce, 231 F. Supp. 3d at 184; Mkt. Synergy, 2016 WL 6948061, at *14.
18Fixed Annuities, 217 F. Supp. 3d at 47; Chamber of Commerce, 231 F. Supp. 3d at 184; Mkt. Synergy, 2016 WL 6948061, at *14.
19Fixed Annuities, 217 F. Supp. 3d at 37; Chamber of Commerce, 231 F. Supp. 3d at 181-84.
20Chamber of Commerce, 231 F. Supp. 3d at 205.
21Fixed Annuities, 217 F. Supp. 3d at 40-45. See also Chamber of Commerce, 231 F. Supp. 3d at 194.
22Chamber of Commerce, 231 F. Supp. 3d at 208-10.
2382 Fed. Reg. 41365.
2418-Month Extension of Transition Period and Delay of Applicability Dates, EBSA (Nov. 27, 2017) (Public Inspection document),
25Brief for Appellees at 60-61, Chamber of Commerce v. United States Department of Labor, No. 17-10238 (5th Cir. July 3, 2017).
26Chamber of Commerce, 231 F. Supp. 3d at 159 n.1; Fixed Annuities, 217 F. Supp. at 21 n.8; Thrivent Fin. for Lutherans, v. United States Dep't of Labo., No. 16CV03289SRNDTS, 2017 WL 5135552, at *6 (D. Minn. Nov. 3, 2017).
27See Thrivent, 2017 WL 5135552, at *8.